Question

“The main reason why inefficiency occurs is profit. Perfectly competitive firms are efficient because they are making zero profit in the long run. If the government can impose regulation to make a monopolist earns zero profit, the monopolist can also be efficient”. Discuss the validity of this statement with suitable diagrams for a perfectly competitive firm and a monopolist.

Answer 1

The statement is incorrect.

Profit does not drive efficiency. If price charged is equal to marginal cost (MC), this is the condition of efficiency.

In perfect competition, firms equate price with MC, thus achieving efficient outcome. But a monopoly faces a downward sloping demand curve, and equates marginal revenue (MR) with MC. Since MR lies below demand curve, MR < Price, therefore MC < Price. Hence monopoly outcome is inefficient.

In following graph, perfect competitive firm maximizes profit at point E where price (demand) intersects MC with efficient price Pc and output Qc. Monopoly maximizes profit at point G where MR intersects MC with higher price Pm and lower output Qm. This gives rise to a social inefficiency loss equal to area of triangle EFG.

P, MR, MC A Pot F Pc MC m MR D Om 90 8